18.1 – Striking it right

The last couple of chapters have given a basic understanding on volatility, standard deviation, normal distribution etc. We will now use this information for few practical trading applications. At this stage I would like to discuss two such applications –

Selecting the right strike to short/write

Calculating the stoploss for a trade

However at a much later stage (in a different module altogether) we will explore the applications under a different topic – ‘Relative value Arbitrage (Pair Trading) and Volatility Arbitrage’. For now we will stick to trading options and futures.

So let’s get started.

One of the key challenges an option writer always faces is to select the right strike so that he can write that option, collect the premium, and not really be worried about the possibility of the spot moving against him. Of course, the worry of spot moving against the option writer will always exist, however a diligent trader can minimize this.

Normal Distribution helps the trader minimize this worry and increase his confidence while writing options.

Let’s have a quick recap –

The bell curve above suggests that with reference to the mean (average) value –

68% of the data is clustered around mean within the 1st SD, in other words there is a 68% chance that the data lies within the 1st SD

95% of the data is clustered around mean within the 2nd SD, in other words there is a 95% chance that the data lies within the 2nd SD

99.7% of the data is clustered around mean within the 3rd SD, in other words there is a 99.7% chance that the data lies within the 3rd SD

Since we know that Nifty’s daily returns are normally distributed, the above set of properties is applicable to Nifty. So what does it mean?

This means, if we know Nifty’s mean and SD then we can pretty much make an ‘educated guess’ about the range within which Nifty is likely to trade over the selected time frame. Take this for example –

Date = 11th August 2015

Number of days for expiry = 16

Nifty current market price = 8462

Daily Average Return = 0.04%

Annualized Return = 14.8%

Daily SD = 0.89%

Annualized SD = 17.04%

Given this I would now like to identify the range within which Nifty will trade until expiry i.e 16 days from now –

These numbers will help us calculate the upper and lower range within which Nifty is likely to trade over the next 16 days –

Upper Range = 16 day Average + 16 day SD

= 0.65% + 3.567%

= 4.215%, to get the upper range number –

= 8462 * (1+4.215%)

= 8818

Lower Range = 16 day Average – 16 day SD

= 0.65% – 3.567%

= 2.920% to get the lower range number –

= 8462 * (1 – 2.920%)

= 8214

The calculation suggests that Nifty is likely to trade anywhere in the region of 8214 to 8818. How sure are we about this, well we know that there is a 68% probability for this calculation to work in our favor. In other words there is 32% chance for Nifty to trade outside 8214 and 8818 range. This also means all strikes outside the calculated range ‘may’ go worthless.

Hence –

You can sell all call options above 8818 and collect the premiums because they are likely to expire worthless

You can sell all put options below 8214 and collect the premiums because they are likely to expire worthless

Alternatively if you were thinking of buying Call options above 8818 or Put options below 8214 you may want to think twice, as you now know that there is a very little chance for these options to expire in the money, hence it makes sense to avoid buying these strikes.

Here is the snapshot of all Nifty Call option strikes above 8818 that you can choose to write (short) and collect premiums –

If I were to personally select a strike today it would be either 8850 or 8900 or probably both and collect Rs.7.45 and Rs.4.85 in premium respectively. The reason to select these strikes is simple – I see an acceptable balance between risk (1 SD away) and reward (7.45 or 4.85 per lot).

I’m certain many of you may have this thought – if I were to write the 8850 Call option and collect Rs.7.45 as premium, it does not really translate to any meaningful amount. After all, at Rs.7.45 per lot it translates to –

= 7.45 * 25 (lot size)

= Rs.186.25

Well, this is exactly where many traders miss the plot. I know many who think about the gains or loss in terms of absolute value and not really in terms of return on investment.

Think about it, margin amount required to take this trade is roughly Rs.12,000/-. If you are not sure about the margin requirement then I would suggest you use Zerodha’s margin calculator.

The premium amount of Rs.186.25/- on a margin deposit of Rs.12,000/- works out to a return of 1.55%, which by any stretch on imagination is not a bad return, especially for a 16 day holding period! If you can consistently achieve this every month, then we are talking about a return of over 18% annualized just by means of option writing.

I personally use this strategy to write options and I’d like to share some of my thoughts regarding this –

Put Options – I don’t like to short PUT options for the simple reason that panic spreads faster than greed. If there is panic in the market, the fall in market can be much quicker than you can imagine. Hence even before you can realize the OTM option that you have written can soon become ATM or ITM. Therefore it is better to avoid than regret.

Call Options – You inverse the above point and you will understand why writing call options are better than writing put options. For example in the Nifty example above, for the 8900 CE to become ATM or ITM Nifty has to move 438 points over 16 days. For this to happen, there has to be excess greed in the market…and like I said earlier a 438 up move takes a bit longer than 438 down move. Therefore my preference to short only call options.

Strike identification – I do the whole exercise of identifying the strike (SD, mean calculation, converting the same w.r.t to number days to expiry, selecting appropriate strike only the week before expiry and not before that. The timing here is deliberate

Timing – I prefer to short options only on the last Friday before the expiry week. For example given the August 2015 series expiry is on 27th, I’d short the call option only on 21st August around the closing. Why do I do this? This is to mainly ensure that theta works in my favor. Remember the ‘time decay’ graph we discussed in the theta chapter? The graph makes it amply evident that theta kicks in full force as we approach expiry.

Premium Collected – Because I write call options very close to expiry, the premiums are invariably low. The premium that I collect is around Rs.5 or 6 on Nifty Index, translating to about 1.0% return. But then I find the trade quite comforting for two reasons – (1) For the trade to work against me Nifty has to move 1 SD over 4 days, something that does not happen frequently (2) Theta works in my favor, the premiums erode much faster during the last week of expiry favoring the option seller

Why bother ? – Most of you may have this thought that the premiums are so low, why should I even bother? Honestly I too had this thought initially; however over time I have realized that trades with the following characteristics makes sense to me –

Visibility on risk and reward – both should be quantifiable

If a trade is profitable today then I should be able to replicate the same again tomorrow

Consistency in finding the opportunities

Assessment of worst case scenarios

This strategy ticks well on all counts above, hence my preference.

SD consideration – When I’m writing options 3-4 days before expiry I prefer to write 1 SD away, however for whatever reason when I’m writing the option much earlier then I prefer to go 2 SD away. Remember higher the SD consideration, higher is the confidence level but lower is the premium that you can collect. Also, as a thumb rule I never write options when there is more than 15 days for expiry.

Events – I avoid writing options whenever there are important market events such as monetary policy, policy decision, corporate announcement etc. This is because the markets tend to react sharply to events and therefore a good chance of getting caught on the wrong side. Hence it is better safe than sorry.

Black Swan – I’m completely aware that despite all the precaution, markets can move against me and I could get caught on the wrong side. The price you pay for getting caught on the wrong side, especially for this trade is huge. Imagine you collect 5 or 6 points as premium but if you are caught on the wrong side you end up paying 15 or 20 points or more. So all the small profits you made over 9 to 10 months is given away in 1 month. In fact the legendary Satyajit Das in his highly insightful book “Traders, Guns, and Money” talks about option writing as “eating like a hen but shitting like an elephant’.

The only way to make sure you minimize the impact of a black swan event is to be completely aware that it can occur anytime after you write the option. So here is my advice to you in case you decide to adopt this strategy – track the markets and gauge the market sentiment all along. The moment you sense things are going wrong be quick to exit the trade.

Success Ratio – Option writing keeps you on the edge of the seat. There are times when you feel that markets are going against you (fear of black swan creeps in) but only to cool off eventually. When you write options such roller coaster feelings are bound to emerge. The worst part is that during this roller coaster ride you may be forced to believe that the market is going against you (false signal) and hence you get out of a potentially profitable trade.

In fact there is a very thin line between a false signal and an actual black swan event. The way to overcome this is by developing conviction in your trades. Unfortunately I cannot teach you conviction; you will have to develop that on your own J. However your conviction improves as and when you do more of these trades (and all trades should be backed by sound reasoning and not blind guesses).

Also, I personally get out of the trade when the option transitions from OTM to ATM.

Expenses – The key to these trades is to keep your expense to bear minimum so that you can retain maximum profits for yourself. The expenses include brokerage and applicable charges. If you short 1 lot of Nifty options and collect Rs.7 as premium then you will have to let go few points as expense. If you are trading with Zerodha, your expense will be around 1.95 for 1 lot. The higher the number of lots the lesser is your expense. So if I were trading 10 lots (with Zerodha) instead of 1, my expense drastically comes down to 0.3 points. You can use Zerodha’s brokerage calculator to get the details.

The cost varies broker to broker so please do make sure your broker is not greedy by charging you ridiculous brokerage fees. Even better, if you are not with Zerodha, it is about time you join us and become a part of our beautiful family ☺

Capital Allocation – An obvious question you might have at this stage – how much money do I deploy to this trade? Do I risk all my capital or only a certain %? If it’s a %, then how much would it be? There is no straight forward answer to this; hence I’ll take this opportunity to share my asset allocation technique.

I’m a complete believer in equities as an asset class, so this rules out investment in Gold, Fixed Deposit, and Real Estate for me. 100% of my capital (savings) is invested in equity and equity based products. However it is advisable for any individual to diversify capital across multiple asset classes.

So within Equity, here is how I split my money –

35% of my money is invested in equity based mutual funds via SIP (systematic investment plan) route. I have further divided this across 4 funds.

40% of my capital in an equity portfolio of about 12 stocks. I consider both mutual funds and equity portfolio as long term investments (5 years and beyond).

25% is earmarked for short term strategies.

The short term strategies include a bunch of trading strategies such as –

Momentum based swing trades (futures)

Overnight futures/options/stock trades

Intraday trades

Option writing

I make sure that I do not expose more than 35% of the 25% capital for any particular strategy. Just to make it more clear, assume I have Rs.500,000/- as my capital, here is how I would split my money –

35% of Rs.500,000/- i.e Rs.175,000/- goes to Mutual Funds

40% of Rs.500,000/- i.e Rs.200,000/- goes to equity portfolio

25% of Rs.500,000/- i.e Rs.125,000/- goes to short term trading

35% of Rs.125,000/- i.e Rs.43,750/- is the maximum I would allocate per trade

Hence I will not short more than 4 lots of options

43,750/- is about 8.75% of the overall capital of Rs.500,000/-

So this self mandated rule ensures that I do not expose more than 9% of my over all capital to any particular short term strategies including option writing.

Instruments – I prefer running this strategy on liquid stocks and indices. Besides Nifty and Bank Nifty I run this strategy on SBI, Infosys, Reliance, Tata Steel, Tata Motors, and TCS. I rarely venture outside this list.

So here is what I would suggest you do. Run the exercise of calculating the SD and mean for Nifty, Bank Nifty on the morning of August 21st (5 to 7 days before expiry). Identify strikes that are 1 SD away from the market price and write them virtually. Wait till the expiry and experience how this trade goes. If you have the bandwidth you can run this across all the stocks that I’ve mentioned. Do this diligently for few expiries before you can deploy capital.

Lastly, as a standard disclaimer I have to mention this – the thoughts expressed above suits my risk reward temperament, which could be very different from yours. Everything that I mentioned here comes from my own personal trading experience, these are not standard practices.

I would suggest you note these points, understand your own risk-reward temperament, and calibrate your strategy. Hopefully the pointers here should help you develop that orientation.

This is quite contradicting to this chapter but I have to recommend you to read Nassim Nicholas Taleb’s “Fooled by Randomness” at this point. The book makes you question and rethink everything that you do in markets (and life in general). I think just being completely aware of what Taleb writes in his book along with the actions you take in markets puts you in a completely different orbit.

18.2 – Volatility based stoploss

The discussion here is a digression from Options, in fact this would have been more apt in the futures trading module, but I think we are at the right stage to discuss this topic.

The first thing you need to identify before you initiate any trade is to identify the stop-loss (SL) price for the trade. As you know, the SL is a price point beyond which you will not take any further losses. For example, if you buy Nifty futures at 8300, you may identify 8200 as your stop-loss level; you will be risking 100 points on this particular trade. The moment Nifty falls below 8200, you exit the trade taking the loss. The question however is – how to identify the appropriate stop-loss level?

One standard approach used by many traders is to keep a standard pre-fixed percentage stop-loss. For example one could have a 2% stop-loss on every trade. So if you are to buy a stock at Rs.500, then your stop-loss price is Rs.490 and you risk Rs.10 (2% of Rs.500) on this trade. The problem with this approach lies in the rigidity of the practice. It does not account for the daily noise / volatility of the stock. For example the nature of the stock could be such that it could swing about 2-3% on a daily basis. As a result you could be right about the direction of the trade but could still hit a ‘stop-loss’. More often than not, you would regret keeping such tight stops.

An alternate and effective method to identify a stop-loss price is by estimating the stock’s volatility. Volatility accounts for the daily ‘expected’ fluctuation in the stock price. The advantage with this approach is that the daily noise of the stock is factored in. Volatility stop is strategic as it allows us to place a stop at the price point which is outside the normal expected volatility of the stock. Therefore a volatility SL gives us the required logical exit in case the trade goes against us.

Let’s understand the implementation of the volatility based SL with an example.

This is the chart of Airtel forming a bullish harami, people familiar with the pattern would immediately recognize this is an opportunity to go long on the stock, keeping the low of the previous day (also coinciding with a support) as the stoploss. The target would be the immediate resistance – both S&R points are marked with a blue line. Assume you expect the trade to materialize over the next 5 trading sessions. The trade details are as follows –

Long @ 395

Stop-loss @ 385

Target @ 417

Risk = 395 – 385 = 10 or about 2.5% below entry price

Reward = 417 – 385 = 32 or about 8.1% above entry price

Reward to Risk Ratio = 32/10 = 3.2 meaning for every 1 point risk, the expected reward is 3.2 point

This sounds like a good trade from a risk to reward perspective. In fact I personally consider any short term trade that has a Reward to Risk Ratio of 1.5 as a good trade. However everything hinges upon the fact that the stoploss of 385 is sensible.

Let us make some calculations and dig a little deeper to figure out if this makes sense –

Step 1: Estimate the daily volatility of Airtel. I’ve done the math and the daily volatility works out to 1.8%

Step 2: Convert the daily volatility into the volatility of the time period we are interested in. To do this, we multiply the daily volatility by the square root of time. In our example, our expected holding period is 5 days, hence the 5 day volatility is equal to 1.8%*Sqrt(5). This works out to be about 4.01%.

Step 3. Calculate the stop-loss price by subtracting 4.01% (5 day volatility) from the expected entry price. 395 – (4.01% of 395) = 379. The calculation above indicates that Airtel can swing from 395 to 379 very easily over the next 5 days. This also means, a stoploss of 385 can be easily knocked down. So the SL for this trade has be a price point below 379, lets say 375, which is 20 points below the entry price of 395.

Step 4 : With the new SL, the RRR works out to 1.6 (32/20), which still seems ok to me. Hence I would be happy to initiate the trade.

Note : In case our expected holding period is 10 days, then the 10 day volatility would be 1.6*sqrt(10) so on and so forth.

Pre-fixed percentage stop-loss does not factor in the daily fluctuation of the stock prices. There is a very good chance that the trader places a premature stop-loss, well within the noise levels of the stock. This invariably leads to triggering the stop-loss first and then the target.

Volatility based stop-loss takes into account all the daily expected fluctuation in the stock prices. Hence if we use a stocks volatility to place our stop-loss, then we would be factoring in the noise component and in turn placing a more relevant stop loss.

What a superb explation you have given with all the reasoning for your own strategy. however i have few minor doubts.

1) Sd you have taught us in last chapters, from where you got “Daily Average Return = 0.04%”

2) your calculated Daily SD = 0.89% while mine is around 0.97% (by applying formula given by you earlier)

3) Since you will be writing call option on 21st i.e. last friday before the expiry, can you not calculate upper & range range for only next six days? by which your range may vary and may get a chance to pocket more premium?

4) Will it be a good strategy to buy ITM options (call/put, according to trend) in the first half /quarter of any month and write only OTM call options on the last friday before the expiry?

1) Daily average is the ‘Average of the daily returns of Nifty’. For daily return I have calculated the log return and not simple return.

2) This could be because of two reasons – data period could be different ( my data if from 12th Aug 2014 to 10th Aug 2015) or you may not be taking the log returns. In fact the same is applicable to your 1st query as well.

3) In fact this is exactly what you are supposed to do. In the explanation the number of days is 16, hence I’ve done the math around that time frame.

4) In one of the subsequent chapters I will talking about which strike to select given the number of days to expiry. That will help you select strike better.

“Then we are talking about a return of over 18% annualized just by means of option writing.” — Man that such an eye opener 🙂 especially for me after loosing tons of money in attempt to be overnight billionaire :). Have few questions

1) If we short a option and 12k is deducted as margin and market goes against me, the at what point does my 12k margin gets exhausted and my position is squared off? –I understand this is worst style of trading, but just want to know for information sake

2) Do you change the entry time if there is holiday in expiry week? say if Monday is off in expiry week would you take position on close of Thursday instead of Friday?

3) And I am 3rd SD sure (99.7% sure) that everyone reading this chapter is curious to know the 4 MF and 12 stocks you invest in 🙂

The key to success in short term trading (at least in my limited experience) is to achieve small but consistent returns…and keep adding them up 🙂

1) If you deposit 12k as margins and short options, then you will have to make sure that this margin amount does not get blown off. You will have to pull the trigger and get out before this happens. Usually this happens when you write OTM option and that option transitions into an ITM option…during this whole transition process your 12k will vaporize.

2) The idea is to write options when there are about 6 days to expiry. But yeah, if there is a holiday then I would not mind shifting 1 more day.

thanks much for your reply mate, very helpful 🙂 on more question that I should have asked before today..but will help for next expiry, if we plan to take position during close of Market on Friday before expiry , should we consider current Market price instead of yesterdays closing ? for example yesterdays closing is 100 points more than CMP of nifty 8268 so If I did calculation in morning with yesterdays close price, I would short 8600 CE, but as per current calculation I have virtually shorted 8500 CE at 8.45…lets see what I get on expiry 🙂

Hi karthik, how does one select the strike price if you are a call option buyer based on the formula you have followed? the e.g are for option writers only. in the bharti airtel e.g above, you have mentioned: [ Note : In case our expected holding period is 10 days, then the 10 day volatility would be 3.01*sqrt(10) so on and so forth]. The daily volatility you have calculated is 1.8% so shouldn’t it be as 1.8%*sqrt(10) ?

Good approach for stop loss. If we are increasing the SL limit then the exposure shall be reduce to limit the total loss per trade to a acceptable level. right, then it will limit the profit also. My another point is that normally it said that ATR (Average True Range) is also related with the volatility. Can it be correlated to the ATR to reduce the calculation time but get the same result.

My one more point is that what will be the impact of variation in the one day price movement on the volatility as about 300 old data are considered. Its effect may be less will be less.

Yes, hence I’ve said that before taking a trade your Reward to Risk ratio should be satisfactory. ATR is not really volatility in terms of “Standard Deviation”….for this reason I don’t prefer using ATR.

If the movement of that 1 day is significant, then it will have the impact to change the volatility of the last 300 days. So better to include all data points.

Yet another great article, Karthik…..One question….If i am looking for a very short term trade (3-5 days) , what is the ideal data time range required for calculating daily volatility? Do i need to calculate it based on closing data for the past 1 year or can it be 1 month, 10 days or some such range?

Volatility, Implied volatility, market volatility, statistical volatility, seems to be confusing. If some event has to happen then also “volatility” increases and affects the option price, how? I don not know if my questions are silly one.

If I were to personally select a strike today it would be either 8850 or 8900 or probably both and collect Rs.7.45 and Rs.4.85 in premium respectively. The reason to select these strikes is simple – I see an acceptable balance between risk (1 SD away) and reward (7.45 or 4.85 per lot)…..karthik, what do you mean by 1 SD away? here 1SD is 3.567%..so how does choosing a strike of 8850 or 8900 effect the SD? secondly if i was a call buyer how would i select the strike price between 8214 and 8818 ?. i know that nifty will swing between this range, but how do i select the most profitable strike price within the range, as the swing is 604(8818-8214) points? what it definitely tells me is not to chose a strike price above 8818. kindly advice. thanks.

Hi Karthik, Thanks a ton for demystifying the options greeks in such a logical manner. One doubt on the above article. In the Nifty example you calculated the Range for 16 Days as 8818 on the upper side (which is 356 away from current) and 8214 on the lower side, (which is 248 away from current), why the range is more larger on the upper side and less on the lower side, as you said falls are more steep than rise, so bit confused with this calculation. I too calculated for different time ranges and got similar results, always upper range was more compared to lower. Please throw some light.

I had just done a beginner course in Nifty options and found it very interesting. In Options, one can gain huge profits both side, if the Nifty goes up or down because in Nifty there is much liquidity and less manipulation. Slowly and steadily, I want to move out of equity and to major extent turned into Nifty Options day trading and position trading. I am finding it hard to know and get good books on options for extra studies and looking at your explanations, I think u r the right person, who can help me out in this regard. I also want to turn into full time trader and investor in future in options. Please help me out. Regards.

Sir,
What to do in such a volatile market as it was today on August 24, 2015. BSE down > 1600 ans NSE down almost 500 points. Now eagerly waiting not only for next chapter on volatility but also for Option strategies. It must be first time such a big crash in a day?

Dear Karthik,
Today, for the 1st time I bought 25 put option at strike 8000 with premium 112 and I sold them at premium 103. Whether I am getting profit or I am incurring loss. Because my position at Zerodha is showing -217.

Karthik,
How do we judge what is a very high IV environment for an Index (Nifty)? Do we compare it to Historical volatility? i.e Can we say we are in a high IV environment if
1) IV of a strike is > Historical IV
2) IV of a strike is > by “X” % of Historical IV
3) VIX is above 10 ema or any such measure?
4) IV is greater than 25% (considering normal IV is observed to be between 15-20%)

What i am trying to evaluate is what can be considered steady state or normal IV and what can be considered volatile or high IV environment

hi karthik, in one of the questions above regarding placing of stop loss using the volatility method on intra day trades, you have said this method works for positional trades only. whats the method then to place SL on intra day trades?

So, you first calculate the daily returns, and then using the =STDEV () function calculate daily volatility. or, you can also use the daily volatility figure mentioned on NSE. then, how do we arrive at average daily volatility?

So we first calculate the daily returns and using the =STDEV() function arrive at daily volatility. or we can use the daily volatility of a stock published on NSE. then, how do we calculate average daily volatility?

STDEV() of daily returns will give you the daily volatility. This you can scale according to the timeframe required. NSE gives you the daily volatility which again can be used. So calculate the daily vol, and then use the STDEV() function.

Karthik , you have replied( So calculate the daily vol, and then use the STDEV() function.)…but, to calculate daily vol we use the STDEV function….what do we do next to calculate average daily volatility?

Dear Karthik Sir,
All the chapters on Option theory Module are that very very useful and easy to understand. Thank you so much for your whole team for this knowledge initiative. Can you suggest some good books on option trading strategy for practical trading purpose? When you will release the 6th module -Option strategies? eagarly waiting for the same.
Thanks.
S.Lawrence

Hello Karthik, very informative chapters.
Just had one doubt.In previous chapter, for calculating upper and lower range, we used the following formula
[
Upper Range
= 8337 *exponential (26.66%)
= 10841]

i.e. We took exponential. But in this chapter, we used [ 8462 * (1+4.215%) ] i.e. Upper Range = CMP * (1+R)

When you take log percentage, its important to convert the same back to the regular % scale. In the 1st method we are directly doing it, in the 2nd weare splitting it over 2 steps….both are essentially the same. Suggest you stick to the 2nd method.

Thank you for very good introduction on Option Theory. I went through all of them over a weekend sitting. 🙂

In your explanations, you have noted that you mostly do trade in Nifty, Bank nifty , and a handful of stocks like Infy etc. Although at the outset, volume , liquidity of stock are important in selecting stock for derivative trading, are there other important factors?

Also do certain stock lend well to certain investors, which can only be determined by actual experience over time.
i.e. Each investor should discover their own set of stocks to trade in?

Because of your long term tracking of stocks like Infosys, SBI , Reliance etc, have you not gained insight into their positional and long term behaviour ? In such a case, is quant more reliable, or gut-feel based on long term observations better?

Wow! did you actually read through the entire module ? Thanks and i hope you found the module helpful!

The main reason why I prefer to trade these stocks is because the liquidity is high in these stocks and therefore the impact cost – you can read more about impact cost here – http://zerodha.com/varsity/chapter/nifty-futures/ , refer section 9.2.

Of course knowing your stocks and their regular movements well adds to the comfort.

I have observed that at some particular occasion both the premium of the CALL and PUT option will decrease at the same time .usually if the call option is loosing then PUT option will gain right .
The Occasion which I experience last year was the next day of the TCS declaration of quarter results . on this date both the call and put looses the premium value..why this will happen can you explain ?

gotcha….apologies karthik. i guess we were using the link you provided earlier to get the historical data for stocks, not realizing that the indices link to get historical data is different…appreciate your patience.

Thanks for helping us download the excel sheet which you have painstakingly worked on,it clears out any ambiquity.Can you please cover topic on OPTION PAIN .Waiting for the strategy for scenarios like the one witnessed on 24Aug15

Hi Karthik ,
Attaching eod chart of AppolloHosp with DarkCloud formation .
I have used daily volatility from nse site.
Holding period we consider are calendar days or should be trading sessions ?
Thanks.

Calculations are right, however the RR depends on the target…and target should not be entry + volatility scaled ti required time. It should come to you by some other means…for example it could come for resistance levels.

Hi karthik, the Daily volatility of Banknifty as per the nse site is 2.10 %. now, using this to place a stop loss for options of a particular strike price, we deduct the DV from the price of entry in case of a call and add in case of a put. is that correct? thanks.

Hi Karthik, can you please address open interest(OI) at some point. Thanks. I also have a recommendation for the people out here to please try the NSE paathsala, before we get into the real market to try the option strategies.

Dear Sir,
Can You please inform in the following formula which is correct :
(1) To calculate intraday price range –
Price*daily volatality*sqrt(1)/sqrt(365) (or)
price*annual volatality*sqrt(1)/sqrt(365) and for positional also can I take the same by inserting number of days to hold. I will be grateful if you can advise. Thanks & Best Regards, R V N Sastry

Dear Sir,
Can You please inform in the following formula which is correct :
(1) To calculate as per 1SD intraday price range –
Price*daily volatality*sqrt(1)/sqrt(365) (or)
price*annual volatality*sqrt(1)/sqrt(365) and for positional also can I take the same by inserting number of days to hold. I will be grateful if you can advise. Thanks & Best Regards, R V N Sastry

Dear Sir,
I would request you to kindly advise whether
( 1 ) the STANDARD DEVIATION Of AVERAGE OF DAILY RETURN is equivalent to DAILY VOLATALITY and if how many days average of daily return is most suitable to calculate STANDARD DEVIATION PRICE RANGE. (2) And also please advise me whether the daily volatality shown in NSE site or Daily volatality arrived by us is more accurate to calculate STANDARD DEVIATION PRICE RANGE. I am very grateful if you can kindly respond and advise me in this matter. Thanking you very much , Best Regards, R V N Sastry

Thanks for this post , things become so clear. However , I would like you to elaborate on identifying the correct strikes that fall within 1SD when I am buying and not writing an option ? Should we consider the IV or should we consider price difference between the theoretical and market price ?

You could give it a shot, worth the efforts I suppose. Make sure you paper trade it before implementing it. Few things to keep in mind –

1) Do not buy options when there are just few days to expiry
2) Stick to ATM or strikes that are few marks away from ATM
3) If the price sticks near the upper or lower band for a long time, maybe the bands are expanding…so make sure you cut the position.

Dear Mr. Karthik,
I have tried to find out nifty range to short for the month of Nov’15. Request you to kindly check and suggest :
• Date = 19th Nov 2015
• Number of days for expiry = 6 days
• Nifty current market price = 7842 (Closing price 19.11.15)
• Daily Average Return = 0.026%

Calculation for Daily Return = (DATA TAKEN FOR LAST 6 DAYS ONLY SINCE 6 DAYS LEFT FOR EXPIRTY – IS IT OK??? or should be more days)

dear Lalitdimple,
great job … just wanted to ask why not short put 7700 ? the price on 18th closing was 14.5 for 7700CE Put Vs 8200 call at 2.30. As on 20th closing the values for 8200 call is 1.15 & 7700 put is 8.70?
Dear Nitin : your expert advice !!!!
just to tell you though i had several options of trading but i have opted for Zerodha and am very happy with the services and it is all because of you. keep up the good job…

Dear Mr. Kumar,
I have gone step by step as per guidance of Mr. Karthik.
He has advised to not short PUT options, although premium is high. On 19th market rose by 105pt so PUT price has gone down. I also thought when saw premium of 1.15, which is of no use.
But the best answer can be given by Mr. Karthik only.
I request for his intervention.

Lalit / Kumar – remember panic spreads faster than greed in markets. So after you write the PUT option, in case panic grips the market (we cannot really predict this) the price you pay will be quite high. Hence I would advice not to write PUT options.

Dear Sir, Which is the better method to put stop loss for Swing and Futures trading. Is volatility method explained above is suits or S&R. Can we fix based on Open Interest Writers.
I have lost max amount of money due to poor strategy in fixing SL though my number of trades are winners than losers. Regards

1) Average True Range (ATR) is an extension of True Range concept
2) ATR is not upper or lower bound, hence can take any value
3) ATR is stock price specific, hence for Stock 1 ATR can be in the range of 1.2 and Stock 2 ATR could be in the range of 150
4) ATR attempts to measure the volatility situation and not really the direction of the prices
5) ATR is used to identify stop loss as well
6) If the ATR of a stock is 48, then it means that on average the stock is likely to move 48 points either ways up or down. You can add this to the current day’s range to estimate the day’s range. For example the stock price is 1320, then the stock is likely to trade between 1320 – 48 = 1272 and 1320 + 48 = 1368
7) If the ATR for the next day decreases to say 40, then it means that the volatility is decreasing, and so is the expected range for the day
8) It is best to use ATR to identify the volatility based SL while trading. Assume you have initiated a long trade on the stock at 1325, then your SL should be at least 1272 or below since the ATR is 48
9) Likewise if you have initiated a short at 1320, then your stoploss should be at least 1368 or above
10) If these SL levels are outside your risk to reward appetite, the its best to avoid such trade.

“These numbers will help us calculate the upper and lower range within which Nifty is likely to trade over the next 16 days –
Upper Range = 16 day Average + 16 day SD
= 0.65% + 3.567%
= 4.215%, to get the upper range number –
= 8462 * (1+4.215%) ” in previous chapter you made use of Exponential function”
= 8818
Lower Range = 16 day Average – 16 day SD
= 0.65% – 3.567%
= 2.920% to get the lower range number –
= 8462 * (1 – 2.920%) ” here also exponential function
= 8214″

if we use exponential function we are getting different answer , please explain what to use and why it is to be added or subtracted from 1 as in previous chapter Volatility & Normal Distribution and in WIPRO explanation you have used the exponential as

If you use simple returns while calculating the daily average then you need to subtract 1. However if you use log return to calculate the daily return then you need to use the exponential function to convert it to simple return.

I’ve demo trade on nifty option at yesterday (02-12-2015). Finally, I got 60.75 rupees profit on investment of around 6000. But, the brokerage charge, 2 times pay-in fund transfer charges and other taxes and charges levied around 77. Totally I book loss from this trade 10.32 rupees and 2 time pay-in FT charges 20.32 rupees. After, that only i know about the brokerage calculation for option trading. I ask the query and gather the information about the brokerage from zerodha support team. They explain the brokerage via email.

These are price filters also called circuit limits as set by the exchanges. This is certainly based on volatility, but I’m not sure about the formula that exchange uses to identify the exact limits for a given stock.

sir,
thanks so much for the valuable information..sir i have a doubt today i am going to a intraday trade in nifty future and my buy price is 7783 and daily volatility of nifty is .78 and my sl will be = 7783-(7783*.78//100)=7722.2 am i right? daily volatility of nifty i got from nse website

sir what if daily returns turns out to be negative
i have calculated it for reliance communication for the past 1 year.
pls do clarify.? in that case how it will be affecting our calculation.
avg daily returns turns out to be -0.08%

Dear Sir,
As your view (1) what could be High range of Implied volatality to sell an option( my guess is above 16) and what could be low range of Implied volatality to buy an option (my guess is below 15). And also kindly advise, at what range of VIX India volatality we can enter into a strategy.
Thanks & Regards,
R V N Sastry

Hi Karthik Sir,
Although you explained Implied Volatility pretty well, I could not understand practical use of it. I mean in the NSE option chain IV keep on increasing from ITM to OTM. Does that mean OTM with more Volatility should be avoided? so, what is a safe level of IV ? I have confusion which strike to choose using IV. kindly explain practical use for it….

IVs play an important role in determining which options/strategies to trade. All this distills down to one important fact – if the IVs are low and you expect the same to increase then try being net long as increase in IV is good for long option position. Likewise if you see that the volatility to be very high and you expect it to fall, then this is conducive for a short trade.

Hi, Do we consider the Current Market price is last days closing price or Price after the pre-market open session. I observed the Nifty is highly volatile during the pre-market open session. In that case how do we predict the Stop loss from the NFO day trading perspective?

Hi Karthik – I used your excel and found the range for reliance as 913 to 1126 today. SO I was just checking the margin required to short Reliance 1120CE expiring on 26 may (Premium 4.2). And the calculator showed the margin as 62000. Is this correct?

Hi,
when should we calculate 1SD,2SD,3SD? from 1st day of the contract or any day while taking entry between expiry or from Resistance point when it is down trend or from support point when it is up trend?

Hi Karthik,
Great work ! I have a alternate idea of calculating the volatility. Please correct me if I am wrong. My idea is , why use a tedious calculation of daily average return, SD etc.. Instead can we use cluster of Bollinger bands with 1SD, 2SD of the desired look back period and determine how the stock might swing above or below the average and write the options. Thanks.

Hello Karthik, first of all, thanks to you for doing excellent job of educating people in a very simple manner. I have a Question. Why the entry price (395) was considered to calculate the volatility based stoploss for Airtel example. Is not it appropriate to consider the mean price over 1 year period? Which one to follow?

Hi Karthik, I must say that your demonstration is absolutely phenomenal, I just have a query, im looking to buy RelCapital call as I’m bullish on it, nse shows annual volatility as 22 and IV for OTM strikes are greaterthan 40, cleaely IV is more than double of historical volatility, so maybe i should holdon till IV comes below 30. Otherwise, decrease im volatility decreases option premium, also i should wait max for a week, after that, if I buy, theta will crush me. I’m a very beginner, please throw some light if my understanding is correct.

If you feel the volatility is higher than usual then you should look at selling the option rather than buying it. As the volatility reduces and falls back to the range, the premium would decrease and you as a seller would profit from it.

Also, for the same reason you should avoid buying options when the volatility is high.

” don’t like to short PUT options for the simple reason that panic spreads faster than greed. If there is panic in the market, the fall in market can be much quicker than you can imagine”.
I quoted your writings in this chapter. I am fully confused now. Selling put options is bullish trade isn’t it? When market falls put option writer will be in safer side isn’t ? Then how option seller will be in risk ?

” don’t like to short PUT options for the simple reason that panic spreads faster than greed. If there is panic in the market, the fall in market can be much quicker than you can imagine”.
I quoted your writings in this chapter. I am fully confused now. Selling put options is bullish trade isn’t it? When market falls put option writer will be in safer side isn’t ? Then how option seller will be in risk ?

Hello Karthik Sir,
I am rather confused with the calculation in 18.1-i.e.- the range between which nifty is likely to trade within the next 16 days, i.e.-8462*(1+4.215%) and 8462*(1-2.920%). My question is can’t we also calculate it like what has been shown in the previous chapter, under solution-1, where the nifty’s CMP has been multiplied with the exponential of the 1 SD, eg. 8462*exponential(4.215%). I am unable to see why there is this difference.

as per you calculation margin amount for shorting NIfty is 12000/- but it has been changed now and it would not give that much returns with the higher margins. Margin Required as on 30th Oct 2016. it is Rs. 47111/-.

I am giving an example with actual data.

on 21st Oct 2016. Nifty Ended at 8693.
if I short 8900 Strike call options I get 75 X 3.75 = Rs. 281.25
which is equivalent to 0.6%. if I do this for 12 months What I would get is 12 X 0.6 = 7.2%. which is less the National Savings Certificate, PPF and most FDs of Banks.

for 8800 Strike it comes 30% annual but with Higher risk.
So in this changed context in Margins requirements do you think it still makes any sense to shorting Nifty Options ?

Hey man I have a very Novice question. I’m having a hard time with these two terms “Option Writing” vs
“Short Selling Call/Put Option”. What I have in mind is – “these two are completely different terms”. And execution process of these terms are as follows,

(As per the example given in this module, the predicted Nifty range is between 8214 – 8818. So we decide to Write (or) Short Call Option at the strike of 8850 for Premium of Rs. 7.45 & the trade goes as excepted)

1) Option writing: Here we are creating a new 8850 call option contract. So in order to create this new contract we need a margin of 12,000 . And we collect a premium of Rs.186.25 from the buyer.

2) Short Selling Call Option: Now the 8850 call option is selling @Rs.7.45 in the market & we simply Short it (like shorting equity stocks in spot market) and hold the short position till expiery – since option positions can be kept for overnight unlike equity postions which should be squared off the same day. And on the expiery day we buy back the option for 0.50 paise, to square of our position (or just simply let it expire – since no STT is charged for Short positions). In this way we do not require a large margin like option writing. All we need is Rs.186.25 / lot. (This gives a insane return of 371%).

Am I right about the shorting concept (or) these two terms (Option writing & Option Shorting) are same and I simply misunderstood the whole concept. I don’t know where I got this idea, but it just stuck in my mind & I’m going goofy with
it, please help me out man.

Vignesh….both ‘shorting an option’ and ‘writing an option’ are essentially the same 🙂

I can tell you, “Vignesh, I shorted an option” or “Vignesh, I wrote an option”….it points to the same trade!

When you short/write an option, margins are blocked in your account….and the margins are released when you square off the short/written option position. You can choose the square off either on expiry or anytime before expiry.

Ah, thank you so much man. “both ‘shorting an option’ and ‘writing an option’ are essentially the same” – this is all I wanted to hear. I was searching for this in blogs & videos, and all I got is more Jargons. You know this guy “Charles Bukowski” he utter intense philosophy in simple words. Your whole module is like that – simple and straight to the point. Once again thank you Karthi.

Hi karthik,
First of all, thanks a lot for sharing all this valuable knowledge. Really appreciate the effort being put forward!!
Coming to my query, I tried putting into application the concepts being taught.
Did all the necessary calculations (mentioning below FYR)
NIFTY Spot- 8406
Daily vol- 0.8%
Daily Mean- 0%
Nifty range- 8242- 8568
The calculation is for the next 6 days and I have taken the data for the last 6 months.
My point is if I really go short on the nearest OTM call which is 8600, the premium bagged is considerably low( 2.45).
whereas in case of nearest OTM put, say 8250, the premium bagged is relatively high( 7.7).

1. Why is there a difference in the prices considering the spot to be much closer to OTM call than OTM put?
2. In this scenario, is it advisable to select a nearer OTM call or go in for shorting of multiple lots of the aforementioned OTM call?

1) This is where the market perception comes into play. Traders are fearful of a fall, hence a higher premium for puts. Also, just because they are fearful, markets need not fall. Markets have the knack of proving everyone wrong, when you least expect it to.

Karthik, I don’t know if this is the right trail to ask this query, but seeing the option chain I get a feeling the market would go bearish whereas on the contrary, moving averages suggest otherwise. Can u explain if this calls out for a neutral options strategy?

hiii,
nice strategy explanation ……. show us some strategies on indicators too……..
well i have one question ……..
1) how to know the movement of the option price with its future ……… say if nifty moves 100 points how much its otm ce or pe will move with it ?
thank you…

Thanks for sharing your great insight on Options. In fact, besides going through your module teaching, I am also picking up a few good points that you mention in the subsequent Q & A sessions of the respective chapter. One thing about volatility, .. after calculating the annualized volatility can I take that figure as the historical volatility of the stock/index and compare it with the IV of any particular strike to understand whether that particular IV is going high or low as compared to the annualized volatility.. thanks

[…] So the next time you place a stoploss make sure you check the ATR value to see if stoploss level is relevant. You may also want to read more about volatility and its application (including volatility based SL) – Click Here […]

Hello Karthik,
First of all congratulations for developing a knack in teaching such complex (or confusing) subject in clear, concise, easy and interesting way. Zerodha varsity is till date the best material for traders have found so far…

I have One question, why range and stop-loss calculations are done in a different way?
e.g. In above examples, to select best possible strike rate, Nifty range for requested no. of days is calculated using daily average return and SD However the stop loss is calculated only using SD (volatility). Is there any reason or did i miss something?

i have calculated yes bank range for 1 sd taking into consideration 1 year back data. the upper range comes to rs 1764 and lower range comes to rs 1484. the spot price is 1546. how to trade in this scenario

Hi Kartik,
The write ups have been really great and useful to a novice trader like me and am sure to a lot others.
Reading these gave me a lot insights about options trading. Keep up the good work.
I have few questions but will limit myself to 1 question on volatility for now.
I wanted to know how do we determine whether the volatility is high or low ? I mean is there a benchmark ? can we treat india vix as a benchmark when comparing individual stock’s volatility ?

it was very nice tutorial given today online but i missed some part.
can you put all calculation with same example of idea stock price?
i have doubt with range, upper lower range , SL , and reward calculation formulas.

i tried to refer video but its not available.
Please do the needful..
Regards

Confusion no 1: I do intaday trading in nifty future. On NSE website daily and annual volatilties are given. But as we know we need average volatility too to calculate following day’s price deviations. But the problem is how to calculate the avg volatity. Well, we can calculate the avg volatility of the underlying (nifty 50 spot).

Hi Sir,
Because of delay on getting Reply, I have gone through all ” 211 ” Comments above … I have got the answer … It was a repeated question from my end …Sorry …

… But I didn’t find a Precise answer to one question, what if the Average Daily Return is Negative ? , it’s really affect the Calculation. You answered to the same question ” KARTHIK RANGAPPA Will try and do this sometime soon.Thanks. ” …

…C an you please come up with a Solution for Negative ADR, Now I am simply changing the Negative in to Positive and using the same ADR value … Is it the right way to Calculate ?

Hi Karthik , Very Happy to see your Reply … one more question please ,
There are many Stocks under gone Stock Split , If we download CSV file of 2 / 3 years, it shows price before Split and after Split with respect to stocks … So how reliable this Data to calculate ADR and SD … SO is there any way to solve it , please clarify it here
Thank you sir …

Ok, here is a rough example – If you have 1000 CE option of Reliance when the spot is trading at lets say 980. Now, you can hold on to the this option, irrespective of the premium till the stop hits 970. 970 is arrived at based on the volatility of Reliance.

Can the daily average return be a negative value. If yes the for the Upper and lower value do we consider the sum and difference 0f the Absolute Values or we add and subtract taking the “- ve” into the calculation

Hi Karthik
If the average return is negative do we have to use the value with the negative sign or absolute value. In the case of INFY the average return is -0.06%.Daily SD =1.47%.. Annualised Average Return -14.82%. Annualised SD 23.24%. Upper Range= 8.52%. Lower Range =-38.16%. If I convert using the CMP of 896 I get upper range as 975 and lower range 612 at one SD. In my view this appears absurd. I have taken the latest one year INFY price from 1st Oct 16 to 30 th Sep 17. Whether the model shown by can be applied to stocks and indexes which are trending down and which as per fundamentals reached bottom? Or any mistake in my calculation?

Now today Bank Nifty Closes at 24437. And Bank Nifty Strike rate 24500 premium closes at 63.13.
Now in case tomorrow bank nifty remain flat or below this value. I will get full premium but yes today my more margin amount will be blocked because of high premium. But if I wait till end of day tomorrow and let my option expire. I will be in profit.

hi kartik,
I have two questions:
1. in the above airtel example you directly used SD to calculate the stop loss, whereas in one of you nifty examples you used avg return – SD to calculate the stop loss, so my question is when to use avg return and when to use the SD directly to calculate the stop loss?
2. sometimes you use log returns and sometimes you use regular returns, so when sould we use Log returns and what is the significance of using Log vs normal returns? (especially if we are going to convert our answer back to normal form anyway by using the exponential function).

I need to review what I’ve written, its an old article. However, I’d suggest you use SD.
If you are converting it back, then you can use log. If your data period is under 1 year, stick to regular. Usually, for large data sets, ppl prefer log.

hi karthik…in the previous chapter you have used the following formula to arrive at the likely levels:
time duration=t
present value=p
daily return=r
daily SD= s
likely range after t sessions =p*e^(rt+s.sqrt(t)) and p*e^(rt-s.sqrt(t))
i understand these are log returns and log standard deviations.so things follow logarithm arithmetic….fair enuf
but in this chapter u have calculated likely range as follows
p(1+(rt+s.sqrt(t))) and p(1+(rt-s.sqrt(t)))… which shows u assume simple mean and SD…
can u please clarify the anomaly

Hi Karthik,
Thanks for adding inputs to volatility queries.Since 365 , 252 or 245 was giving me sleepless nights though of talking directly to the NSE IISL team on index constructions and got to know how they make volatility calculatuions.They dont follow the normal SD calculation .A bit complicated way based on previous day volatality , log return and current day volatality and squarerooting 365 for AV calculation or GARCH MODEL for INDIAVIX. Volatality data of all FO scrips in “all daily reports” of MONTHLY REPORTS in equity derivatives in PRODUCT link.

1. How do I know the timings for monetary policy, policy decision, corporate announcement etc?
2. Is there a site which has all this data in a single place?
3. Can you list down all the main events (policy etc that you discussed) that we should be aware of ?
4. Stop loss needs to be put on a daily basis?
Won’t that be a pain for part time traders?
5. On what basis should we decide on a holding period for an underlying?

Hello Sir,
First of all I would like to thank you for sharing such an ocean of knowledge that you had with us it’s like a feeling that we are being guided by the best cricketer to learn cricket thanks a lot for your effort sir and the simplicity you provide that helps us to understand wonderfully once again thanks a lot. And I had also compared Zerodha brokerage charges they are way low from the traditional brokers of the market you are just doing an mind blowing job.
Now coming to my question.
Sir can you please help me finding out the lowest and the highest volatility of a specific stock or option as it will help us to know wheatear the stock that is trading with a implied volatility of 38 or 40 is its average volatility or it is with high or low volatility because sir there is different volatility for different stocks so I am confused in knowing wheatear the volatility of an option or stock is running high or low?
Eagerly waiting for your reply
Thanks & Regards,
Ketan. 🙂

Thanks for the kind words, Ketan. I’m really glad that you are enjoying your experience with Zerodha.

The only way to get a sense of how today’s IV is with respect to the historical vol, then you will have to plot the volatility cone. Unfortunately, this is not really available as a tool anywhere. Hopefully, we should be able to plug this gap soon.

Thanks for your reply sir.
As you said the only way to track IV is through historical volatility.
So can we do it from the average of the historical volatility available till now and calculate its SD and can we see the IV keeping the mean and the SD in perspective of historical volatility. Will it give us a view on if the volatility is high or low. And also maybe we can apply it only for the ATM options as from there we know that IV behaves as volatility smile. And I am waiting for the day when Zerodha will invent the volatility cone tool it will be the best that one option trader can get for trading options.
Thanks a lot for your efforts sir.

You can check the average historical volatility and compare that against the current day IV. But do remember this technique is only an approximation. Not really the clean way to do it. Hopefully, the options tools will roll faster from our end.

Hi Karthik,
Could you please let me know if 1) ” since inception CAGR annualized daily return compounded daily “of an underlying stock is the same as since inception log return and does it have any mathematical relation with DV 2)For DV calculation since inception data input or yearly data input gives more precision if the intention is for price velocity and price acceleration tracking than risk tracking. Chaotic random motion and butterfly effect has how much effect on volatility?

Daily log returns give you the daily returns, CAGR, on the other hand, gives you the year on year growth rate. For daily volatility, you need to take the daily return data. Anything else would distort the numbers.

1) I had started straight away started with the options theory module and wasn’t aware of the Bullish Harami pattern (which I assume had been shown in a previous chapter), so should I read some of the earlier chapters first before moving forward from this chapter onwards? Same goes for Futures chapter. Haven’t read it, though I know the concept somewhat (at the very basic level). Personally, I was thinking of reading this and the next (option strategies) module first before moving to either Futures or Technical Analysis chapter.

2) Is there some program/software where the (excel) calculations shown in the last few chapters can be done automatically? Some of us may not be that well versed with Excel.

Hi Kartik,
Thanks for sharing such wonderful knowledge about options. Have a query on the above chapter.
1. From where did you get the Daily SD = 0.89% & Annualized SD = 17.04% numbers.
Understand the daily returns & annualized returns calculation from last chapter but could not get the SD values.
Pls share your feedback, thanks.
Rgds Dipankar

” I prefer to short options only on the last Friday before the expiry week. For example given the August 2015 series expiry is on 27th, I’d short the call option only on 21st August around the closing. Why do I do this? This is to mainly ensure that theta works in my favor. Remember the ‘time decay’ graph we discussed in the theta chapter? The graph makes it amply evident that theta kicks in full force as we approach expiry.”

My question is : Do you exercise option on expiry or square-off before expiry?

Hi Karthik,
Nice write up as always! My compliments!
Was wondering whether you could help me with the following queries:
1. Can we apply volatility based stop loss in intraday time frames? Like on hourly or half-hourly time frames (even though I intend to hold the position for a few days)? What would be the formula in that case?
2. In the example above, you took the nearest resistance as target which is great, but how can we identify a potential target if the price is breaking it’s previous highs or lows? Or in other words, it’s trending up or down, beyond past resistances and supports?
3. Also, how can we calculate the approx. holding period within which it reaches the target? Like in the example, you mentioned 10 days. How did we arrive at that?
And this I am asking w.r.t Equities. Would appreciate your help. Thanks.
~ Abudhar al Hassan.

1) Yes, you certainly can. Calculate the daily Volatility range on EOD basis (have explained the formula in the chapter itself), and identify the stops
2) In such cases, its always a good idea to trail your SL
3) No standard measure here. You just have to wait till it triggers your target

hello Karthik,
Loved this chapter. I have a question regarding the volatility based stop-loss.

let’s assume that during a trading day, I find an opportunity to short a go long at Rs.1000 in any particular stock at 12:50 pm ( 15 min chart ). The daily volatility of a stock is 1.25 %. but the last day closing price is 996.
So should the stop be at 1.25% of 996 i.e around 983? or the stop should be at the 1.25% of 1000 i.e 988.
Basically should I place stop loss order according to last day closing or desired entry price?
Thanks

Suppose on Friday (22/12), the spot is around 10,500 & I write the 10,700 call option (premium around 4). On expiry day, around 3:20, if the spot is at 10,600-
1) Should I square off my position or let it expire? In which case will my profit be higher?
2) Secondly, I’m assuming that the premium would be near 0 by then. Am I right in assuming that?

You have done an incredible job by writing difficult concepts in a very lucid manner so that anybody and understand. I have a couple of doubts regarding the topics covered in this chapter.
1. Throughout the chapters on options theory and options strategies, you have explained with graphs how to choose the strikes (for both calls and puts) with expiry in perspective. Now, does Standard Deviation find its application in only writing options and not for buying?
2. In one of the examples in this chapter where the Nifty’s range has arrived as 8214 and 8818, you have mentioned since we are 16days away from expiry it is better to sell Call options (in OTM range-8850 &/or 8900) and collect the premium. If we sell 8900 strike call option and if market expires at 8500, if we buy the option at 8500 and close the position, apart from the premium will be getting the difference between the strike and spot multiplied by the lot size?

I think the second question is very silly or basic. As explained by you Intrinsic value for call options is spot minus strike and by virtue of which the option would expire worthless and we retain the premium. I request you to clear the doubt on the first question.

Thank you very much for your guidance. In my view, after going through options strategies I feel during the second half of the expiry series if we find the range in which the Index or Stock toggles then we can set up Short Strangle to be in small/decent profits consistently. Correct me if I am wrong.

Sir,
Let’s say i bought a 10500 strike price
call option buy @75 rs premium.suppose i missed to square off my position on expiry day and the option expired @10600. Will i lose the whole money , else 25 rs is my profit?

No, not necessary that you square off. The Option will be exercised since its in the money.
Intrinsic Value will be 10600-10500= Rs 100. After deducting the charges, you’ll be settled with the net amount by the broker.
Note- STT will be higher if the option is exercised. Read more here

Since the topic is almost two years from now..so do u still use the same techniques to select strikes and sell calls and also is it still 5-6 days before expiry? You had shared some stocks in the chapter in which you prefer to sell calls have u added some more to the list ??

Secondly in a section capital allocation in this chapter u named Momentum based strategy ( futures ) which u use..have u shared that here in varsity..if yes please share the link and if no please give a hint what is all about..

Hello Karthik,
I shorted Banknifty 26300CE yesterday (6-2-18) which is expiring tomorrow (8-2-18) and the premium which I received was 23 which was about 1.3% Return and the spot was around 25300. Surprisingly spot moved to about 1000 points in around 30 mins or some thing. And the option which I had shorted was near to atm. Leaving me no choice but to close the trade at a loss of 10% of capital.
So my question is, if I am trader who is not comfortable in losing more than 2% in any single trade. Is this strategy of writing the options near the expiry suitable for me?If it is how can I place my stops because my premium could move to 2% or more and eventually cool off at the day of expiry . If I place my stops say like 2% from my entry, it will most likely hit my stops and cool off at the time of expiry. So how should I deal such cases?
Thank you.

Nihkil, when you write options, you need to make sure you account for volatility. A 1000 point move on bank nifty is very common. So account for this and write options which are outside the expected volatility range. When you do this, you will have staying power and therefore higher chances of making a profitable trade.

Your article on Volatility based stoploss was really enlightening and it really helped me expand my knowledge on calculation of Stops .
If possible for you, can you please let us know how do you calculate the Stoploss for a Call option using Volatility, do you use IV(Implied Volatility) or do you use the Volatility of the underlying. A small example will be helpful, please consider the following scenario:

Q. How do you calculate the days until expiry ? Do you calculate it based on the number of working days for the market ?
Q. How do you calculate the Stoploss for this Strike using Volatility ?
Q. Do we need to consider other Geeks also to calculate the Stoploss, for example Gamma, since it is against the Options Seller ?

Thanks for replying so promptly. Like you said that we need to do the calculations of StopLoss on the Spot Market. That makes sense.

Suppose if I am writing a Call Option and the Option starts moving against me(spot starts to increase in price), then by the time the Spot Market reaches the Stoploss(Volatility based stoploss), the Option may have had a sufficient increase in price to damage my trading account, so how do you think can we counter this ?

You will have to plan the options trade by looking at the price on the spot. For example, spot is at 10500, hence I decide to write the 10600 CE @ 45. Now spot moves to 10620, I decide to close the trade at 56. The point is that I’m not really looking at option price here – I’m working on the spot. The option price is incidental. Having said so, there are times when I work purely on option price, irrespective of the spot price. There is no one rule that fits all situations, varies based on case to case basis.

Dear Kartik,
Thanks for the valuable information you post in your site for free.It really helped me in adding to my passion for understanding market dynamics To my limited understanding scientific version of price motion seems that If the motion of prices were with uniform velocity and uniform acceleration , price motion would have it plotted as straight line if depicted in a chart showing linear motion.But in reality prices moves with variable velocity and variable acceleration and hence when plotted we it is seen as zigzag with nonlinear motion. Economic version of price movement seems that price moves with varied speed and varied volatility and this volatility gives opportunity for traders to trade and make money in the markets. Had the volatility been constant and speed be constant prices would have moved in a straight line and investors would have got fixed returns in fixed time lengths.(CAGR over an year and log return on a daily basis. If volatility and speed is zero then prices would not move and traders will have no opportunity. Returns in the market (positive or negative)are as a result of dispersion from the price equilibrium point created by demand and supply at that instance. A new equilibrium point is created with each trade and based on the equilibrium point in the underlying is the futures equilibrium point and options equilibrium point evolved. In Indian market context the shift of equilibrium point is seen set at 5 paisa for all scrips and indices. The shift of the equilibrium point in underlying translates its effect to the futures equilibrium point in turn passing its effect on to the options equilibrium point with option pricing following the underlying pricing based on its sensitivity of the first , second and third order. Dynamics of the equilibrium point shift is complex and not merely apparently visible demand and supply. It is neither totally fundamental nor technical but natural like a river flow around the theoretical value line. It is a mixture of rational calculus and irrational randomness with butterfly effects playing its role .The whole market seems mathematically programmed and marketmaked in such a way that when underlying moves(without any effect of time) futures and options too moves in a mathematical way dependant on time length to expiry. Fundamental analysis tries to look the linear motion of the underlying value based on macros and micros and not bothered about the noises in between where as technical analysis is bothered only on the effect of the noises benchmarking certain points in economic space like price ,volume and open interest but not taking the time length and underlying value. If robots with artificial intelligence could be created with infinitesimal calculus skills and chaos reading skills which can comprehend, synthesise analyse and evaluate infinitesimal data, macro and micro, it would be good bye fund managers over period of time . Many conglomerates are already on the move to tap AI. Could happen within a decade . Lets wait and see. Would appreciate if I could have your email id to explain you some scientific versions of price motion if price is equated to a mathematical object and the principles of Newtonian motion and chaotic motion is applied along with mathematical and economic theories.

I agree with the uniform acceleration and velocity bit, that depicts a rather safe asset like a fixed deposit. The variable nature of speed (also called Delta in the options world) and velocity (also called as vega in options world) gives scope for setting up the trade and hopefully profiting out of it.

Hello karthik sir,
Thanks for clarifying my last question. i have a doubt what is india VIX telling me about. Means india VIX for in a time is @14% is it representing IV of NIFTY 50 if yes then suppose i am taking a trade in a option market for say a naked call buy whatever strike and IV volatility for that strike is @ !9% then how india VIX will help me to decide to go ahead and take this trade or just leave it basically i want to know connection between India VIX and option chain EVEN a particular strike in a particular option chain and i also want to know thought process behind this trade step by step assume all other variables are constant you just focus on INDIA VIX and on strike price.
And thanks for your valuable efforts

HI sir,
i wanna know that if i am right
Todays realized volatility will be read as historical volatility tomorrow if yes then this must be fine
realized volatility(1-jan-2017) = Historical volatility (1-jan-2018)

Hello sir,
I have few questions:-
1.if I want to buy a naked call option of a particular chain’s particular strike than how to utilise India vix
Say I have different strikes and IV figures such as, 10300(ITM), 10400(ITM),10550(ATM),10700(OTM),10850(OTM),10900(OTM) & 12%,14%,16%,35%,22%,19%respectively and at the same time India VIX is at is at @19%
2.You wrote this line in option module’s India vix topic
“NSE computes India VIX based on the order book of nifty options”
What do you mean by this line
Are you saying volatility of nifty underlying or nifty future are based on nifty’s option or even on a particular nifty option chain or strike

3. In next line you said “The best bid-ask rates for near month and next-month Nifty options contracts are used for computation of India VIX” Which are they best bid-ask rates are they belongs to particular ITM,ATM OR OTM strikes.

4. INDIA VIX can swing between 0 and 100 but Who will decide that India vix value is in high, low or normal range means what is the reference behind saying it’s high ,it’s low or it’s sideway.

5. Can I consider if india VIX is high then option are expensive to buy because strikes must be trading at higher volatility due to higher India vix value. Assume direction will be sideway in coming days.

6. Do we use historical volatility in option calculator or implied volatility
To get theoretical premium value.
& How theoretical premium differ due to different volatilities used in option calculator.

7. IV increases before big events is understandable to me but Why sometime volatility decreases exponentially without any reason or big event and premium became cheap. I was watching March expiry of nifty and a strike which was almost ATM and it’s volatility was @ 1.35% and premium was 0 .so why this happens.

8. How to know how much is the realized volatility in number or percentage term like Implied, historical or forcasted volatility you did not described about this in option theory module ( I didn’t read option strategies module yet)

9. You said there is four type of volatility exists Historical,implied,forcasted and Realized volatility
In case of implied volatility you said it represents the participants expectation on volatility it mean that they are expecting something for future because expectation take place in future then what is forcasted volatility is doing here
Then what is the difference between forecasting volatility and implied volatility are they both same

1) As a rough back of the envelop, I’d consider all options above 19% IV as expensive in terms of volatility
2) You can check the details on India ViX here – https://www.nseindia.com/products/content/equities/indices/india_vix.htm
3) Check the details from the above link
4) I think historically, 26-30% is the highest it has reached, hence this should serve as a benchmark. On the lower side, it have touched close to 8-12%
5) Yes
6) IV
7) This can also happen due to pure demand supply reasons – although not frequent
8) Forecasting Vol is your expectation based on your forecasting model, IV is market’s expectation.

I am new to option writing and have read your content and must say it is excellent and lot of concepts are clear. Before I go into writing an OTM option i wanted to know if, i write a call option of Nifty 10800 @ 4.55 today and let it expire – is my understanding correct that I will pocket a premium of 341.25 (75×4.55) – (the STT + Brokerage + SEBI charges + Stamp duty i.e 23.81). So, eventually 317.44 should come in my account of Feb 22 2018.